The Effect Of Stock Market Development On Economic Growth In U.K.

Write an essay “The Effect of Stock Market Development on Economic Growth in U.K.”.

The topic of this particular research is – “The Effect of Stock Market Development on Economic Growth in U.K.”.

It has been found that from the last two decades, the development of the stock market and its effect on the economic growth has earned an immense attention from the managers, practitioners and academicians. The reason behind this is their attempt to study and also to understand the market development and financial and their contribution to the economy. It has been noted that the capital markets of the world have been improved drastically with the passage of time. This has compelled the authorized institution to take decision regarding share market in the both emerged and emerging countries. According to the World Bank, the improvement of stock market is much associated with the total improvement and growth of the financial system. The development of the financial sectors help in allocating the resources and this in turn helps to boost up the economy (Thompson 2012). This study mainly focuses on the development of the stock market that plays a central role in the estimation of the future growth of the economy.   

• To critically identify and analyze the Government Revenue, Government Expenditure, Stock Market Capitalization, Gross Domestic Product (GDP) and Foreign Direct Investment of U.K.
   
• To critically examine the relationship between the GDP and Stock Market Capitalization.
   
• To critically evaluate the importance of Stock Market Development in the economy of U.K.
   
• To critically scrutinize the correlation between the stock market capitalization and economic indicators over the last decade.

Q1. How are the Government Revenue, Government Expenditure, Stock Market Capitalization, Gross Domestic Product (GDP) and Foreign Direct Investment of U.K. defined?

Q2. What is the relationship between the GDP and Stock Market Capitalization?

Q3. What is the importance of Stock Market Development in the economy of U.K.?

Q4. What is the correlation between the stock market capitalization and economic indicators over the last decade?

It has been found that the stock market plays an important role in the developed countries and it also enriches the economic condition of a particular country. Thus, the aim of this research study is to study the effect of the stock development in the future economic growth and also to develop the stock market of developing countries. The intention behind this is to bring the economic condition of the developing countries in line with the developed countries. Thus, the evaluation of the performance of the London Stock Exchange in the economic growth of U.K. has been considered as an interesting as well as an important topic for this proposed research study.  

The positioning of this research study is composed of the conceptual framework and also the review of the previous studies, journals and articles on the stock market development and its impact on the economic growth. These theoretical underpinnings are comprised of conceptual framework that is related to theories, concepts and information of stock market and economic growth. All these theoretical underpinnings will help the researcher to understand the issues regarding the research and also to identify the existing gaps both practically and theoretically.

Research Objectives

This section mainly deals with the concepts and the history that are associated with the economic growth and stock markets.

Equity market or stock market is a place where the shares are traded i.e. one can buy or sell the secondary shares to another. This does not indicate any physical transfer of assets; rather transfer in terms of certificates. Opined to Mayer and Steneck (2012), this market is developed on the basis of the demand and the supply of the sellers and buyers. According to Kensinger (2013), the London market serves an efficient platform for trading and it also regulates the market by monitoring both the market activities and trading. LSE has two markets – firstly, the main market which is considered as the dwelling place for both U.K. and also for world’s best and largest companies. Indranil (2012) stated that the enlisted companies in the Main Market of the London Stock Exchange (LSE) have high standards and these kinds of companies are able to collect capital from widest range of investors. It has been found that the Main Market is capable of collecting about £ 366 billion from new issues and additional issue of stocks (Londonstockexchange.com, 2016). Secondly, LSE has sub-market especially for minor organizations in order to float their stocks in the particular market with flexible method of regulation compared to the Main market. Alternative Investment Market (AIM) is its other name and here hundreds of overseas companies are enlisted along with smaller companies of U.K. According to Ghossoub and Reed (2012), more than 3000 companies across the world along with smaller companies of U.K. move down to AIM. The reason behind this is that with the reduction in the various regulatory costs, the firms can improve their liquidity position and it also helps to expand their businesses by raising funds. As per Indranil (2012), the AIM is the best place for investment for the knowledgeable shareholders who possess more capacity of analyzing risk and who are able to perform the research quickly on the release of the company news.

According to Thompson (2012), the financial system plays a vital role in the growth of economy of a country. It has been found that the stock market plays an intermediary role between the borrowers and lenders by supplying the capital to an individual who really needs it. The financial intermediaries help in reducing the transaction costs for both the saving people and investing people by reducing the asymmetric information. However, this sophisticated derivative instruments and the development of such markets help in the diversification of risk. Supino and Borer (2012) stated that when the financial market is considered as more efficient, rapid economic growth takes place. The importance of the stock market lies in various factors. These include – firstly, the stock market helps in raising capital for a business, secondly, it helps in mobilization of savings properly for the investment. Thirdly, the stock market plays a vital role as it facilitates the growth of an organization and also helps in redistribution of the wealth. In addition to these, the stock market guides in structuring the corporate governance, it acts as the barometer of the economy and this market also helps in the creation of the facilities regarding investment.     

Interest and Importance of Topic Chosen

As per Shiller (2012), the previous studies indicate that there are various indicators which are essential for analyzing the development of the stock market or equity market within any country. It has been found that there are a few theoretical and empirical research works on the determination of the development of the capital market in the emerging markets. It has been found that the important microeconomic factors like income level of the people, investments, stock market liquidity and development of banking sectors are the most essential and effective determinants of the development of the market. The particular study was conducted for the time period of 14 years by considering 42 countries (Seivewright 2012). The key indicators of the development of the stock market include – market capitalization, capitalization ratio and liquidity.

Market capitalization – It is considered as one of the most used indicators for the development of the stock market. The market’s size has a little impact on the size of the nation. As per the study of the World Bank, the dimension of the share market is generally calculated in various methods. Of them, the market capitalization is considered as an indicator which represents the total dimension of the capital market. As per Plattner, Meinel and Leifer (2012), this also indicates the investors regarding the ability of the market to mobilize the total capital. In addition to this, the degree of extending the diversity of risk is also measured, which is related to the selling and buying of shares in the secondary market.

Capitalization ratio – It is considered as the ratio of domestic shares that are bought and sold on the share market on the basis of GDP. It is counted as an essential indicator of the development of share market. Generally, the capitalization ratio helps in analyzing the size of the market and also in diversification of risks at various markets. Haites (2013) stated that the relationship between the stock market and the long-run growth of the economy can be better determined by using this capitalization ratio.

Liquidity – This indicates the volatility of a stock that makes the investors able to buy or sell the stocks through the stock exchange. It has been found that if the liquidity of a stock is high, then the risk that is associated with the shares are relatively low. Goodson, Loveless and Stephens (2012) stated that the liquidity is considered as the chief indicator of the development of the market as it helps in improving the allocation of capital and also encourages the growth in the long run.          

Positioning of the Research

According to Ghossoub and Reed (2012), the increase in the output of the economy over the time period is termed as economic growth. In this state, the economy is changed from one particular growth rate of per-capita income to another. Opined to Evrensel (2013), the Western Capitalist Economies has increased the output since from the initial stage of the Industrial Revolution. This growth is optimistic for the longer period of time. Eun, Resnick and Sabherwal (2012) stated that the growth rate of economy is the augmentation of the industrious sectors of the country’s economy in the long run. These particular budding economies offers or serves the earnings for each individual in order to enjoy their improved living standard with the increase or rise in employment within the country.

The growth in the output of the economy generally takes place with the increase in the input factors. This indicates the more the equipments will be purchased, more the workers will enter the workforce. This is termed as capital accumulation. Opined to Brealey, Myers and Marcus (2012), it has been found that there are mainly four aims that are central in order to evaluate the macroeconomic performance. These four objectives are – output, price, employment and foreign sector.    

Opined to Berk, DeMarzo and Harford (2012), there are various factors that have been found to influence the rate of economic growth of a country. These include – confidence of business people and consumer, aggregate demand of the U.K. trading partners, decisions of business leaders, monetary policy, population growth and fiscal policy. The other factors involve – productivity growth, tax policy and government policy. Baker and Riddick (2013) stated that the U.K. government always tries to support the businesses by deducing the fiscal deficit by developing the macroeconomic stability. This macroeconomic stability is considered as the most essential factor. It has also been noted that the British Government comes up with various ambitious programs regarding reforms for the improvement of the business environment. The government has also taken actions for reducing the deficit with the aim to improve the country’s economic condition by bringing financial reform programs. In addition to this, the government also brings the transparency and credibility in their decision.

The research methodology helps the researcher to study about the research topic and also helps them to describe, predict and explain their work. Therefore, implementation of proper research methodology within the study is an important factor as this guides the researcher to gather information and various data regarding the research topic and also to analyze them by using proper statistical methods (6 and Bellamy 2012).

Conceptual Framework

The information regarding the performance of the stock market can be assessed only from the two approaches i.e. macroeconomic and institutional. It has been found that the later approach is mainly used to find out the development within the institutions.  Opined to Creswell (2014), the institutional approach is composed of various issues that are associated with disputes settlement process, transparency and property rights. on the other hand, Chandra and Sharma (2013) stated that the macroeconomic approach is used for studying the factors that are associated with investment, savings, growth and inflation. However, in this particular research study, the macroeconomic approach will be implemented though both the approaches are equally valid. In addition this, scientific methods will be applied for data analysis with the aim to get realistic and reliable results. Thus, proper design and planning will be done to provide a more systematic and clear modality and framework. Therefore, an exploratory study will be performed in order to investigate the growth index, trends and percentage changes to locate the directional of the study.

This particular study is based on the fixed sample size i.e. FTSE 100 Stock Index of the LSE as one of the variables in order to identify the performance of the stock market. It has been found that this particular index covers around 80 % of the total market capitalization (Londonstockexchange.com 2016). This sample size is counted to be significant for this research study as the researcher considers this fixed sample size to be enough for revealing the population.

Various data and information regarding the research topic can be gathered from both the primary data resources and secondary data resources.

In the secondary data collection method, the data will be gathered from the annual statistical data that are generally published by the International Monetary Fund (IMF), FTSE 100, London stock Exchange (LSE), World Bank and Yahoo Finance. In addition to this, the researcher will also gather data and information from the related websites.

The primary data collection method is the research method where the researcher collects data and information directly from the concerned people or the people who have knowledge regarding the research topic. The researcher can gather the primary data by two methods, i.e. through online or offline questionnaire survey and through face-to-face or telephonic interview. The primary data and information that are collected by the researcher through online or offline questionnaire survey are generally analyzed through quantitative analysis method. On the other hand, the data that are collected through face-to-face interview or telephonic interview are usually analyzed through qualitative analysis method (Habib, Pathik and Maryam 2014). This particular research study is also based on the primary data collection method. Here, the researcher will opt for online questionnaire survey for finding the useful indicators of the development of the stock market and economic growth in the country. On the basis of the primary data collection, the quantitative analysis of the gathered data will be performed.

Capital Market and London Stock Exchange

The data and information that will be gathered through primary data collection method will be analyzed through the regression model and other statistics. This portion of other statistics will include – Coefficient of Correlation (R), Coefficient of Determination (R^2) and Descriptive Statistics. The descriptive statistics generally include the data and information quantitatively regarding the features of data among selected variables. Here, the mean and standard deviation of all selected variables will be calculated for FDI, GDP, Government Revenue and Government Expenditure. The descriptive statistics will help to provide the historical account of the selected variables in a summarized way. On the other hand, the coefficient of determination is calculated by squaring the value of correlation coefficient. This helps to measure the goodness of fit of the model. In other words, it can also be said that it measures the percentage proportion of the total variation in the dependent variable as per the regression model. The rationale for using coefficient of determination that is R-square is to identify and measure the closeness of the regression beta of the independent variable which explains the dependent variable (Novikov and Novikov 2013). Therefore, it can be said that the R-square quantifies the goodness of fit of the equation. In addition to this, the coefficient of correlation will also be used by the researcher in order analyze the collected data as this helps to find and understand the relationship between the selected variables. Therefore, this particular analysis will provide an initial idea regarding the relationship between the selected variables that might hold high moderate, perfect, zero or low correlation. According to Daniel and Sam (2015), the further relationship of the variable analysis is ineffective unless one applies the correlation analysis. The mathematical formula of coefficient of correlation is as follows:

Here, Yt and Xt are two different sets of variables and Y and X are two mean variables.

Lastly, the most important model i.e. the Regression model will also be implemented by the researcher in this study in order to examine the cross-sectional determinants of GDP. In this study, multiple regressions model will be implemented such that GDP can be regressed against the market capitalization along with the other explanatory variables. Here, GDP will be considered as the function of FDI, market capitalization, Government Revenue and Government Expenditure. This might be stated as:

GDP = f (FDI, MKTCAP, GVTEXP, GVTREV)

On the other hand, the multiple regression equation is as follows:

Importance of Stock Market

Opined to Grand and Jonas (2012), the consideration of other variables of economic indicators within the particular model will provide actual direction to the study. Thus, in this study, the regression model will also be used in order to analyze the problem statements in detail.

The ethical consideration indicates the respects towards the values and rights of the people during performing the research. This particular research will provide utmost care during the collection of data and information and also during processing, analyzing and concluding the study. This study will ensure the participants about confidentiality and each individual will be treated autonomously and equally. The researcher of this particular research study also ensures about the fair and unbiased selection of variables. The study will take consent of the people wherever necessary and enough follow-up will be done.

Conclusion

Therefore, it can be concluded that the particular research will be able to fulfill its objective that is to investigate the relationship between the economic indicators and the stock market indicators. It can also be said that both the primary and secondary research methods are essential for this study as these will help the suggested research models and parameters to evaluate the economic growth indicators and stock market indicators. Finally, this can also be said that the successful research work will help the future researchers to research further on this particular topic or any such similar topic.

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